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Executives

Joseph J. Lombardi - Chief Financial Officer

Mitchell S. Klipper - Chief Operating Officer

Marie J. Toulantis - Chief Executive Officer of Barnes & Noble.com

Analysts

Matthew Fassler - Goldman Sachs

Bill Armstrong - C.L. King & Associates

Charles Grom - J.P. Morgan

Danielle Fox - Merrill Lynch

David Schick - Stifel Nicolaus

David Weiner - Deutsche Bank

Barnes & Noble, Inc. (BKS) F4Q07 Earnings Call March 20, 2008 10:00 AM ET

Operator

Good day and welcome to this Barnes & Noble fourth quarter 2007 earnings results conference call. Today’s call is being recorded. At this time, for opening remarks and introductions, I would like to turn the call over to Chief Financial Officer, Mr. Joseph Lombardi. Please go ahead, sir.

Joseph J. Lombardi

Good morning and welcome to Barnes & Noble's fourth quarter and year-end 2007 conference call. Joining us today are Mitchell Clipper, Marie Toulantis, and other members of the senior management team. Steve Riggio did not plan to attend the call today. In his absence, Mitch will have comments after my remarks before we take questions.

Before I begin, I would like to remind you that this call is covered by the Safe Harbor disclosure contained in our public documents and is the property of Barnes & Noble. It is not for rebroadcast or use by any other party without the prior written consent of Barnes & Noble.

This morning before the market opened, we released our earnings for the fourth quarter and full year ended February 2, 2008. As previously announced, consolidated sales totaled $1.8 billion for the quarter and $5.4 billion for the year. As you may recall, fiscal year 2007 was 52 weeks and fiscal year 2006 was 53 weeks. Excluding the impact of the extra week last year, consolidated sales grew 4.6% or $236 million.

Sales at Barnes & Noble stores were $4.6 billion for the year, up 4% over a year ago, excluding the extra week. Comparable store sales decreased 0.5% for the quarter and increased 1.8% for the year.

In the fourth quarter, we opened nine Barnes & Noble stores and closed five, for a quarter end total store count of 713. In addition, we closed seven B. Dalton stores resulting in a total B. Dalton store count of 85.

Sales through barnesandnoble.com were $477 million for the full year. Excluding the impact of the extra week during fiscal 2006, online sales increased 13.4% for the full year on a comparable basis with the prior year.

In trade books, fiction and the genres had a strong quarter, especially graphic novels and romance. Hardcover sales were driven by a host of familiar names, including Sue Grafton, Dean Koontz, Ken Follett, Stephen King, and a holdover from the spring, Khaled Hosseini’s A Thousand Splendid Suns.

Both John Grishman and James Patterson had two bestsellers; Grishman with Playing with Pizza and The Appeal, and Patterson with Quickie and Double Cross. Trade paper fiction was driven primarily by movie tie-ins and selections from Oprah Winfrey. Movie tie-ins included The Kite Runner, Atonement, and I Am Legend, and the Oprah recommendations for Pillars of the Earth and Love in the Time of Cholera drove the sales of those titles.

In non-fiction, areas of strength included biography, humor, health and diet books, as well as the continuing success of Rhonda Byrne’s The Secret. Other key hardcover titles included Stephen Colbert’s I Am America, Tom Brokaw’s Boom!, The Dangerous Book for Boys and its sequel, The Daring Book for Girls, and Michael Palin’s In Defense of Food.

Non-fiction movie tie-ins also included in non-fiction were Into The Wild and Charlie Wilson’s War.

Our gift, DVD, and children’s businesses all performed particularly well during the fourth quarter. Gross profit margins decreased 80 basis points this year, primarily due to the discounts associated with the increased benefits to our member program and to a lesser extent bestseller markdowns associated with the seventh and final Harry Potter book.

The gross margin rate was slightly better than the forecasted 90 to 100 basis point decrease, partly due to sales mix as we sold less lower margin music during the fourth quarter, as well as a more favorable physical inventory shortage rate than estimated, which we discussed in the third quarter.

The fourth quarter margin rate declined 100 basis points, due both to deleveraging fixed occupancy costs, as well higher promotional costs compared to a year ago.

Our selling and administrative expenses were 30 basis points unfavorable as a percentage to sales. This is primarily due to the legal expenses incurred during the first half of the year, as well as some deleveraging on expenses due to the slightly negative comparable store sales performance during the fourth quarter. Included in expenses are store closing costs and asset impairments of $0.14 per share.

Net earnings per share were $1.79 for the fourth quarter and $2.03 for the full year, in line with guidance updated on March 3rd. The company’s capital expenditures for 2007 were $197 million, in line with guidance of $190 million to $200 million. The company’s operating free cash flow was $201 million for the year, higher than the $190 million approximation updated on March 3rd and higher than the $150 million forecasted at the beginning of the year due to working capital improvements.

At year-end, the company’s balance sheet and financial condition remain in excellent shape, inventories increased less than 1% on the sales increased of 4.6% on a comparable 52-week basis. Inventory turnover improved from 2.57 to 2.63 times, the highest level in the company’s history.

We began the year with $349 million in cash. During the year, we acquired 6.9 million shares of BKS for $248 million. We issued $39 million in dividends and we ended the year with $360 million in cash and no debt.

The company has acquired an additional 1.9 million shares during the first quarter for $52.7 million. The company has approximately $150 million remaining under the current share repurchase authorization.

The company remains committed to increasing shareholder value and on Tuesday, the board of directors authorized a $0.10 increase to its quarterly cash dividend to $0.25 per share.

And now for 2008 guidance; as previously stated, we believe that the recessionary pressures in this uncertain economic environment will make 2008 an especially challenging retail year. In addition, the company is facing difficult sales comparisons, as we cycle against the seventh and final Harry Potter book and improved hardcover sales last year.

Based on these factors, we expect comparable store sales to be slightly negative during the first quarter and slightly positive for the full year. Last year’s first quarter if you’ll remember included phenomenal book and DVD sales for Rhonda Byrne’s The Secret, the bestselling combination non-fiction book and DVD title in our history.

In 2007, the company had a number of non-operating or non-recurring benefits and costs which impact the comparison of earnings per share results with 2008 guidance. I’m just going to take a minute to lay them out for ease of understanding.

Included in earnings per share in 2007 are four benefits: a second quarter tax benefit of $0.12 per share; a third quarter shrinkage benefit of $0.09 per share; and fourth quarter gains on property insurance and litigation settlements of $0.10 per share. Also included in 2007 are two costs from the first quarter totaling $0.13 per share related to the closing of our Internet distribution center and legal costs.

Excluding these items, earnings per share for 2007 was $1.85. As previously announced, the company’s full year earnings per share are expected to be in a range of $1.70 to $1.90. First quarter net earnings per share are expected to be in a range of $0.05 to $0.10 against last year’s reported loss of $0.03 per share. Excluding the previously mentioned DC closing and legal costs from the first quarter last year, the company had net income per share of $0.10 in 2007.

The effective tax rate to be used for 2008 is forecast to be 40.0%. We are also forecasting operating free cash flow of approximately $125 million to $150 million in 2008 and gross capital expenditures between $200 million and $210 million.

We plan on opening 35 to 40 stores this year and closing approximately 20 stores. As is the company’s standard practice, no assumptions have been made regarding future share buy-back from the guidance for 2008; however, we have included the first quarter to date buy-backs announced in this release in our computation of the fully diluted share count and our earnings per share guidance.

At this point, I’d like to turn the discussion over to our Chief Operating Officer, Mitchell Klipper.

Mitchell S. Klipper

Thanks, Joe. Good morning. I’d like to begin with a business review, followed by our 2008 outlook. Our earnings for 2007 showed a planned decrease in gross margin through the full year impact of the new lower prices for Barnes & Noble members that we instituted in October of 2006. To be clear, we intentionally invested these gross margin dollars directly to our best customers in order to strengthen our long-term position in the marketplace.

While price has never been the number one reason that book buyers cite as a factor in choosing where to shop, it has become more important in the past few years and of course, it’s even more important online. Although we were disappointed in our overall holiday sales results, the key drivers of our negative comp store sales was the rapid deterioration of the music business in the fourth quarter.

However, I would like to point out some of the positive highlights for 2007. First, the company achieved record sales. With comp store sales growing 1.8%, the addition of 31 new stores, we managed to keep building our business. As Joe mentioned earlier, we added $236 million to the top line through all of our distribution channels.

In addition to growth in bookstore sales, we achieved record Internet sales in 2007. Sales grew 13.4%, which is the strongest growth in more than five years. When people choose to shop online, they consider a number of factors, including trust in the brand, price, selection, speed of delivery, and resolution of customer queries.

In the past year, we’ve become much stronger on three key metrics. First, we’ve become much more competitive on price due to our new lower prices to members. Second, we offer very fast delivery. Most of our orders are shipped UPS without additional customer charges for the services. And third, the relaunch of our website last October, as well as the new functionality added to the site -- these three metrics have increased our traffic and our page views.

Not only did our new lower prices on hardcover books make us more competitive, we also saw record growth in our member program. We added more new members in 2007 than any previous year since the launch of the program. The growth was also significantly greater than we forecasted. And just as important, the percentage of members that are renewing are higher than ever. Our members and our customers come to our stores and visit our website because of the depth of our selection.

We sold a record number of titles last year -- more than $1.1 million unique titles and as Steve has said for many years, we are in a long tail business. A large percentage of the books we stock sell only a few copies each year. Our supply chain and distribution systems were designed to fulfill the library of titles which our customers expect from our brand. One title we’re especially proud of was our illustrated edition of Peter Yarrow’s and Lenny Lipton’s classic song, Puff the Magic Dragon, which sold over 0.5 million copies for Sterling Publishing.

In 2007, we finished our distribution network optimization strategy with the closing of our Internet fulfillment center in Memphis. We can now service all of our customers in two much more efficient facilities serving one brand. And as a result of our efforts in the supply chain, we’ve had our fifth consecutive increase in inventory productivity to a new record level of inventory turnover.

Now for 2008 -- we will continue to open new stores, 35 to 40 locations this year, inclusive of entering new markets as well as upgrades. We will continue to make improvements to our websites. Our recently launched Barnes & Noble studio is the web’s first and largest destination for multimedia about books and authors. Barnes & Noble studio incorporates innovative original video programming and podcasts as well as those supplied by publishers and independent producers.

While this will be a challenging year for all retailers, we believe our position in the marketplace is strong. We continue to offer the most competitive products and services, staying on top of the bookselling business as it evolved over the past decade. Prices have been lowered, we’ve invested in a first-class real estate portfolio, and our IT systems enable us to execute world-class service.

In addition to investing in the business, the company has delivered value to its shareholders year after year, using its cash to buy back $890 million of our stock and issuing a quarterly dividend, which today has been raised substantially. Our strong balance sheet and financial condition allows us to continue to provide value to our shareholders while fulfilling our commitment to our customers and our booksellers.

Joseph J. Lombardi

Thank you and now we’d like to turn it over to questions.

Question-and-Answer Session

Operator

(Operator Instructions) We’ll take our first question from Matthew Fassler from Goldman Sachs.

Matthew Fassler - Goldman Sachs

Thanks a lot and good morning. You talked about the impact of the promotional environment in the fourth quarter. If you could give us some color, kind of big picture, Mitch or Joe, about where you think that’s headed in the long run, whether you think the industry can sustain that level of promotional activity. And then also perhaps let us know if that has continued past the holiday period.

Mitchell S. Klipper

As has been our record for actually more than the fourth quarter, it’s really been quite a few years now that the industry has been very competitive, very promotional. We set our promotional targets to be out there and compete as effectively as we can to drive sales and make profits. We launched our discount to members and we are very happy with that. We are happy with the growth in the member program and the business continues to be competitive. Retail is a tough business and it’s very competitive and I think we believe that we are well-positioned to compete in that marketplace, and so we see and we kind of have guidance out there which suggests that there will continue to be a lot of competition and discounting in the book arena.

Matthew Fassler - Goldman Sachs

The second question I have relates to your first quarter guidance. At the high end of that guidance, your earnings would be roughly flat, relative to the first quarter of last year, despite a negative comp and that’s frankly a little better than we thought you would do in the first quarter with the kind of comp that you are discussing. So anything in particular that, either on the growth side or anywhere else, that you are deploying to offset the deleverage associated with soft sales?

Joseph J. Lombardi

The only thing I’d add to that, Matt, is that obviously with the tough sales guidance that we have, we are looking at every expense and giving everything a second look and doing what we can to manage the leverage. That would be the only reason we’d be at the upper end.

Matthew Fassler - Goldman Sachs

Understood. Thank you so much.

Operator

Our next question comes from Bill Armstrong from C.L. King & Associates.

Bill Armstrong - C.L. King & Associates

A follow-up on that first question regarding the pricing environment; would you characterize any of your competitors as maybe having some irrational pricing promotion and have you seen any change in that behavior, either for the better or for the worse since the holidays?

Mitchell S. Klipper

We don’t comment on what our competitors are doing. We set our pricing strategy throughout the year. We adjust it accordingly based on what’s going on in the retail environment, in the competitive environment, so I won’t comment on what my competitor is doing but we think we have a plan, we stick to it, we adjust it accordingly and we move forward.

Bill Armstrong - C.L. King & Associates

Okay. And in Q4, you had a couple of favorable items -- were those both in SG&A, on the SG&A line?

Joseph J. Lombardi

Both in sales and in SG&A. The income from the litigation settlement is in sales and is about $4 million of that, and $6 million is in the SG&A line for the property settlement, insurance settlement.

Bill Armstrong - C.L. King & Associates

So the litigation is in sales?

Joseph J. Lombardi

It is other income, if you will, miscellaneous income.

Bill Armstrong - C.L. King & Associates

Okay.

Joseph J. Lombardi

It’s not sales, it’s miscellaneous income.

Bill Armstrong - C.L. King & Associates

Got it. Okay, obviously one of your biggest competitors, Borders, had a big announcement this morning. Would there be any interest on Barnes & Noble’s part in potentially acquiring Borders?

Mitchell S. Klipper

We haven’t been approached by Borders’ investment bankers and if we are, we’re certainly take a good look at the company and put it under review.

Bill Armstrong - C.L. King & Associates

All right, thanks.

Operator

Our next question comes from Charles Grom from J.P. Morgan.

Charles Grom - J.P. Morgan

Just a follow-up to that last question regarding the Borders announcement. I’m wondering if you could, if you’ve looked at the store overlap between the two companies, I’m sure you have, and I wonder if you could share with us how many of your locations are in the exact same zip code, or maybe within five miles or ten miles or some sort of metric?

Mitchell S. Klipper

We always look at all our competitors and where they are located, but as far as the overlap, it’s not something we’re going to comment on.

Charles Grom - J.P. Morgan

Okay. And then just I guess a second question here; given almost a negative real rate today with the fed cutting, I’m wondering if you could speak to the company’s appetite to leverage up a little bit on the balance sheet and you know, obviously buy back stock.

Joseph J. Lombardi

I think the company’s past four-year history is we’ve been using our excess free cash flow to buy back shares. We announced a dividend. I think we made a statement today by increasing the dividend, a substantial increase that the board authorized us to do and we think that that right now is prudent.

We believe -- we are very happy with our financial condition on our balance sheet. It gives us a lot of flexibility and we have no plans to announce any different intention at this point related to what we might or might not do with the balance sheet.

Charles Grom - J.P. Morgan

Okay. One last one, if I could; could you, Joe, I know we’ve talked a little bit about this in the past, what your fixed cost hurdle rate is going to be in 2008. I’m not sure if you guys have been able to go through and find some savings opportunities. I believe in the past it was around a 2. I’m just wondering if it’s a little bit lower this year.

Joseph J. Lombardi

No, we suggested you should still use a 2% comp leverage.

Charles Grom - J.P. Morgan

Okay, thanks.

Operator

Our next question comes from Danielle Fox from Merrill Lynch.

Danielle Fox - Merrill Lynch

Thanks. Good morning. Two questions; first, I just wanted to talk about your full year view for comps. It looks like you’re anticipating a little bit of a sequential improvement. Is that a function of something that you see going on broadly that will create a more accommodating selling environment or is that a function of easing comparisons?

Mitchell S. Klipper

It’s a function of easing comparisons in the back half, as well as things that we know that we did in the fourth quarter that, you know, some things that worked really well and some things that didn’t work well and obviously some learnings from that. But obviously the comparisons in the fourth quarter are the easiest comparisons we’ll have.

Danielle Fox - Merrill Lynch

Okay, thanks. And the second question is just the outlook for CapEx. You provided some guidance. It looks like CapEx is going to be stepping up a little bit. It also looks like you are planning to open a bit more stores, but then offset that with maybe more store closings. Can you talk a little bit about your CapEx plan this year and how it differs from last year?

Mitchell S. Klipper

The basic change in the CapEx is the store count. Remember we did have some stores fall off in ’07 that fall into ’08. Actually, the first quarter of ’08 we have quite a few openings compared to a normal run-rate, and that’s really the major difference.

Danielle Fox - Merrill Lynch

Thank you.

Operator

(Operator Instructions) We’ll take our next question from David Schick from Stifel Nicolaus.

David Schick - Stifel Nicolaus

Good morning. I just wanted to hear your general comment about traffic into the stores these days and as you came out of holiday and how you feel about traffic trends versus ticket trend.

Mitchell S. Klipper

Well, traffic is probably flat to down a little bit from what we’ve seen. I mean, most of our stores are located in great retail centers, so we are a by-product of what happens in retail. At the same time, we are a destination retailer so the traffic is remaining somewhat consistent, it’s down a little bit.

David Schick - Stifel Nicolaus

Okay, so down a little -- it’s fractionally down, is that the way to think about it? There’s no big change in traffic in the last few months?

Mitchell S. Klipper

No.

David Schick - Stifel Nicolaus

Okay. Thank you.

Operator

Our next question comes from David Weiner from Deutsche Bank.

David Weiner - Deutsche Bank

A lot of my questions have been asked but I’ll just ask this -- could you give your thoughts on the emerging electronic format for books and how you might consider participating -- if you think it’s a valid format and if so, how you might consider participating in it. Just any thoughts or color on it would be nice. Thanks.

Marie J. Toulantis

Well, you know certainly e-books have been around for a long time. It still remains a very small market, albeit obviously growing but when you look at the percentage growth, remember it’s growing off of such a very small base. We continue to look and evaluate and we’ll make decisions about when and if to jump in at the appropriate time.

David Weiner - Deutsche Bank

Would the -- are you more -- do you think the reader format or kind of the downloading in the store format, if that even is a valid format, do you think one of those is a better format than the other? I mean, have you evaluated both or --

Marie J. Toulantis

You know, I think it’s too early to tell what’s going to be the better formula. I mean, it’s still such early days. In terms of downloading in the stores, I think there’s only one store in the whole country that even has that. Whether or not that’s successful remains to be seen and again, the total e-book market is still very, very small so we’ll carefully evaluate it and we’ll make the appropriate evaluation and decision based on that analysis when and if to invest.

David Weiner - Deutsche Bank

Great. Thanks.

Operator

Your next question comes from Bill Armstrong.

Bill Armstrong - C.L. King & Associates

Just a quick follow-up; you said you were going to close 20 stores. Are we talking about all superstores or is there a mix of superstores and Dalton stores?

Mitchell S. Klipper

All of our guidance on closings relate to superstores.

Bill Armstrong - C.L. King & Associates

Okay. How many Dalton stores could we expect to be closed this year?

Mitchell S. Klipper

Ten to 20.

Bill Armstrong - C.L. King & Associates

Ten to 20 -- okay, thank you.

Operator

(Operator Instructions) We have no more questions at this time. I’ll turn it back to you, Mr. Lombardi.

Joseph J. Lombardi

Thank you for listening to our final fiscal year 2007 conference call. Please note that our next scheduled financial release will be our first quarter sales release on or about May 22nd.

Operator

This does conclude today’s presentation. Thank you for your participation and have a wonderful day.

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Source: Barnes & Noble F4Q07 (Qtr End 2/2/08) Earnings Call Transcript
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